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Growth investing is a popular investment strategy that has been used by investors for decades. It involves buying and holding shares of companies with the potential for above-average earnings growth. These companies may be part of fast-growing industries and are often high-risk, high-reward investments.
While growth stocks can deliver higher returns over time, they are also subject to volatility, making them suitable for long-term investors who can tolerate market fluctuations.
Here’s how to identify growth stocks and make the most of growth investing.
How growth investing works
Growth investing is a strategy that aims to increase an investor’s capital by investing in companies with above-average earnings growth. Growth stocks have the potential to deliver higher returns than value stocks over longer periods of time, but are also more sensitive to volatility. During market downturns, growth stocks can experience significant price drops, so it’s important for investors to take that into account.
Growth investors focus on the growth potential of a company or market and look at factors such as strong earnings per share growth, profitability, revenue growth and efficient use of capital. However, some growth stocks are not profitable, so investors will focus more on potential growth than on actual profitability indicators.
“Growth stocks are generally high-risk, high-return investments. To reduce the risk of investing in individual securities, it may make more sense to invest in a growth-oriented mutual fund or an exchange-traded fund,” said Ted Rossman, senior industry analyst at Bankrate.com. “And consider growth stocks as part of a broadly diversified portfolio that can include other types of stocks in addition to bonds, cash, real estate and/or commodities.”
What are the characteristics of growth stocks?
These are the characteristics growth investors are looking for:
Fast growing industries: Growth investors tend to invest in companies that operate in industries that are expected to grow faster than others. Technology and healthcare are two examples of sectors expected to grow faster than average. Growth stocks generally have high valuations.
Economies of scale and competitive advantages: Companies with competitive advantages such as network effects, economies of scale and high switching costs would have a greater chance of weathering market downturns. These are companies that can reinvest profits to grow faster than their competition.
High price-earnings ratios: Growth stocks can have a higher price-to-earnings ratio than value stocks.
How to find growth stocks
To find growth stocks, investors should look for companies that have promising positions in emerging industry niches with the potential for long-term expansion. It is also important to understand the company’s business model and future earnings potential. For investors who don’t want to pick individual stocks, there are plenty of exchange-traded growth funds (ETFs) and growth index funds to invest in.
Keep in mind that growth stocks are generally recommended for long-term investors who can tolerate some volatility. This strategy is best suited for investors with a long investment horizon and who are able to absorb short-term fluctuations in the market.
Growth versus value investing
Growth investors focus on companies that have achieved above-average earnings growth and are expected to continue to do so. They focus on companies with promising positions in emerging industry niches, and are willing to pay a premium to invest in growth. While they may buy a stock if it is offered at a discount, they are more interested in future potential than current stock prices.
Value investors, on the other hand, look for undervalued companies based on a number of metrics such as price-to-earnings ratio, price-to-book ratio, price-to-sales ratio, price-to-cash flow ratio and dividend. yield. They believe that paying a lower price for future cash flows leads to higher returns. Both strategies have the same goal: achieving higher returns, but use different approaches.
Historical data shows that value and growth stocks move in cycles, according to Kiplinger. While growth stocks fared much better than value stocks in 2020, they fell in 2023. Overall, value stocks appear to be the winner in the long term, at least according to Dimensional Fund Advisors, an index investing specialist who looked at the returns of value stocks versus growth stocks of 1927 until 2023.
In short
Balancing a portfolio with other types of stocks and assets can make growth investing a sustainable strategy. By buying stocks when they are down and holding them for the long term, investors can reduce the impact of short-term volatility and take advantage of the potential upside.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making any investment decision. In addition, investors are advised that the past performance of investment products does not guarantee future price increases.
